pro rata value improvements over their average workers’ contribution? I don’t think so!
I am not against large rewards for CEOs who create sustained value for stakeholders. I get it as a former senior executive in a $24 billion company away from home over 65% of the time working on mergers, acquisitions, partnerships, and other significant corporate matters. My company paid me handsome compensation, bonus, and share options. So, I have no difficulty recognizing CEO’s value creating contribution. But let’s not overlook the CEO’s potential to destroy serious value. In the current system, firms don’t penalize CEOs, instead, often they pay delinquent CEOs vast sums to eject them. And the tragedy is many firms don’t pay fair compensation to their workers.
Three aspects of Ceo Compensation concern me. The size, the gulf between CEO and the median worker’s pay, and the myth that higher CEO pay and incentives lead to improved company performance.
Size and Composition of CEO Compensation
Here are three examples of CEOs’ compensation in 2021.
Does Tim Cook and Andrew Jassy need such large amounts of stocks to motivate them? Keep in mind they have substantial stock options, too! If they need these monstrous amounts as extrinsic motivation, they shouldn’t have that job. What about giving much less in stock awards to CEOs and providing lower levels with modest amounts of stock awards? Some companies give stock awards to lower levels, but this practice needs to be more pervasive and larger.
CEO-to-Worker Ratio Is Too High
From 1978 to 2020, adjusting for inflation, top CEOs’ compensation rose 1,322.2% about 60% faster than the stock market growth, eclipsing the measly 18.0% growth in the average worker’s compensation. CEO pay does not reflect their skills; they use their clout with impunity to set their pay. This is outrageous when studies show no correlation between CEOs’s pay and their performance.
A study published in the November, 2009 issue of the Journal of Business & Economics Research used a database of CEO compensation for 200 large public companies which filed proxy statements with the SEC for 2007 found there was a significant correlation between total compensation and total revenue… the larger the sales, the more its CEO received. But there was no significant correlation between total CEO compensation and change in net income or change in Total Shareholder Return (TSR).
Morgan Stanley Capital International’s (MSCI) August 2016 research confirmed no link between CEO compensation and stock performance. MSCI sampled 429 large-cap U.S. companies from 2006 to 2015 and concluded Ceo Pay did not reflect long-term stock performance. Companies in the sample that awarded CEOs higher equity incentives had below-median returns. On a 10-year cumulative basis, CEOs in firms who got less than median pay outperformed those that exceeded median pay by almost 39%. Other studies show similar results.
Why Don’t Shareholders and Directors Lower CEO Pay
Why do we provide such huge amounts to CEOs? Is it because they feed their greed unchecked with friendly board members? We get a glimpse of what’s happening from a Harvard Law School Forum on Governance paper titled: CEO Compensation: Evidence From the Field posted in July 2021. The paper surveyed over 200 directors of FTSE All-Share companies (firms on the London Stock Exchange) and over 150 investors in UK equities on how they design CEO pay packages: their objectives, the constraints they operate under, and the factors they consider.
- 65% of directors viewed attracting the right CEO as most critical, while 34% prioritize designing a structure that motivates the CEO. For investors, these figures are 44% and 51% respectively.
- Directors and investors view CEO ability as the most important to decide CEO pay.
- 77% of investors view CEO pay as too high, and many believe large cuts would have no adverse consequences.
- Most directors disagree that CEO pay is too high.
This last point is the crux of the matter… it’s board members who should reign in compensation.
Greed has infected the c-suite. CEOs appoint sympathetic board members who bolster their short-term views to boost next quarter’s profits, often crushing long-term value. Disney’s CEO, Bob Chapek, ($32.5 million 2021 compensation, 644 times the average worker) is the poster child of this approach. Without the pandemic’s effect, Disney’s share price fell 40% over the past five years; yet, this guy extracts huge amounts from the business! That’s why Abigail Disney, grandniece of Walt, accused Disney of exploiting its workers and she appears set to mount a proxy battle at the next annual general meeting.
The Way Forward
CEO-to-worker ratio must fall. But most of all, lower-level workers’ compensation must rise to recognize their major positive effects on the firm. The CEO might develop strategy, policies, and significant plans, but it is the frontline workers who interact with customers; they will cause customers to abandon the business. Research shows 96% of unhappy customers don’t complain, while 91% of those will simply leave, never to return.
The late management guru, professor, and author, Peter Drucker, said there was an ideal CEO-to-worker ratio of 20-to-1. Maybe it is, maybe it isn’t. Firms must pay fair living wages to all workers and pay justifiable and realistic amounts to CEOs. Developing a living wage is subjective. Amounts will vary from firm to firm and location to location. One approach is to develop a base salary plus cost-of-living adjustments for different locations. Beyond this level, add reasonable stock awards. Reforms to CEO pay should include penalties for value destruction like that caused by CEOs at Disney, Facebook, Wells Fargo, Pfizer among others, and ego-driven mergers and acquisitions that do not realize promised gains (most don’t).
I am not a fan of corporate taxation because its focus is on the inanimate shell, the entity, that’s run by people. We must tax people, not the vehicle that produces goods and services. Tax funds leaving the entity to pay employees, pay dividends, to buyback shares, and at higher rate, for CEO and other c-suite compensation exceeding a defined ratio to the median worker’s remuneration. Then, abolish corporate taxation. In 2021, Berkshire Hathaway Inc’s (Warren Buffett’s firm) ratio was 6:1 and Alphabet Inc’s (Google’s parent) 21:1. They are at the bottom of the infamous CEO compensation-ratio group led by Amazon at 6474:1. The key to setting this ratio is improving wages at the bottom to a reasonable living wages.
Stakeholder Capitalism Won’t Provide Needed Answers to fix Capitalism’s Flaws
© 2022 Michel A. Bell
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